U.K. banks raising mortgage interest rates…cause inflation hasn’t fallen as much as expected. Can anyone do an ELI5 as to why?

As the title says, numerous banks in the U.K., maybe across the world, are raising interest rates on mortgages, and the given reason is cause inflation hasn’t fallen as much as expected. Can anyone give me a basic inflation, other than greed, as to why they’d do this?

frog ,

I'm sure someone else can do a much, much better explanation than I can, but... As I understand it, it comes from the perception that inflation is driven by a "too much demand" problem (ie, too much money in the system chasing the same amount of goods), and by raising interest rates they discourage spending and encourage saving, both serving to reduce demand.

Obviously there are valid questions about whether raising interest rates to deal with a "not enough supply" problem actually helps or causes more harm - and given that the current inflation was initiated by Russia's invasion of Ukraine, which resulted in supply disruptions. The problem was not a surplus of money, but a deficit of goods. And, of course, a lot of things most hit by inflation are impossible to meaningfully reduce demand for, like food and electricity.

I have suspected for a while that raising interest rates to deal with inflation is largely a "when all you have is a hammer, everything looks like a nail" situation: the Bank of England only has one tool - changing interest rates - so when faced with a problem, the only thing they can do is raise or lower interest rates.

deegeese ,
@deegeese@sopuli.xyz avatar

Government lends money to banks. Banks lend money to homeowners.

When inflation is too high, the government charges banks higher interest, so banks charge customers higher interest.

Fewer people take out loans, so there is less cash circulating in the economy, which dampens inflation.

At least that’s how it’s supposed to work.

shortwavesurfer ,

If it did work that way, it might be all right. But you're forgetting that the banks only have a like 5% reserve requirement. So for every thousand dollars they get in the bank from an account, they can lend out 950 more. And they can do this again and again until it hits zero, which is about 9 times. So you end up turning $1,000 into About 9,000.

deegeese ,
@deegeese@sopuli.xyz avatar

The real world is far more complicated and fractional reserve is just one small part of it.

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